Martinsa Fadesa: Asset value drops 30%, liabilities much larger

FT Alphaville is reporting that Martinsa Fadesa, the bankrupt Spanish property developer, has seen the value of its drop 30% this year alone. Spain has largely slipped from view as the credit crisis has reached global dimensions. However, it bears remembering that Spain, along with the U.S., the U.K. and Ireland have been at the forefront of residential property price falls.

The real story here is the potentially criminal inflation of asset valuaions, something that plagued the American residential property market. See details in the translation below. But, first, the FT Alphaville comments:

The administrators of Martinsa-Fadesa have submitted a report that values the assets of the insolvent Spanish real-estate company at €7.34 billion, sources said.

According to reports in El Pais, the valuation of the assets is about 30% lower than the figure arrived at earlier in the year by CB Richard Ellis.

It gets worse (emphasis ours):

The administrator values Martinsa-Fadesa’s liabilities to just under 10,000 creditors at €7.156 billion, compared with the €6.3 billion declared by Martinsa Fadesa in July. The report was submitted to creditors last week and lists Martinsa-Fadesa’s assets and liabilities as well as the ranking of the creditors.

I found the original Spanish source, and translated it. The article is quite damning as it shows lapses by auditors, appraisers, lenders and the company itself. Note the asset value inflation of 32%, which I have bolded. This story sounds as if it could easily have been written in the U.S., the U.K. or Ireland:

The report by the directors of Martinsa’s bankruptcy reveals some accounting entries that allowed the company to say that it had closed 2007 with profits despite its precarious financial situation.

But in addition, according to this document, the administrators interposed a demand “without delay” to terminate all the guarantees demanded by financial institutions which participated in the refinancing of Martinsa’s debt to ensure the recovery of other previous commitments. Some entities already renounced these guarantees when Martinsa filed for bankruptcy. In addition, the administrators will determine if the refinancing of the 4,000 million euro loan by Martinsa aggravated the situation. They want to clarify whether “the information available to members of the syndicate of banks was sufficient to know that said refinancing would not prevent bankruptcy.” More than 40 organizations took part in the loan. Among them, La Caixa, Caja Madrid and Banco Popular Savings Corporation, among others.

Lawyers and economists are warning of the possibility that a judge, at the request of administrators, may cancel operations it considers detrimental to creditors within the period of two years preceding the date of the declaration of bankruptcy, as contemplated by Article 71 of the Bankruptcy Act. They do so because they believe that certain conditions and safeguards imposed by banks (the most common, mortgaging or divesting more assets) can be detrimental to the “mass” of creditors, but also because they fear that managers will be asked to nullify payment in kind ( deliver assets to the banks in exchange for canceling credits) until the purchase by another company.

But the investigation of administrators reveals further that the value of Martinsa-Fadesa’s assets (essentially land) was inflated, according to new valuations carried out by three firms for taxation. That will require the company chaired by Fernando Martin to rewrite the accounts that informed the Commission Nacional del Mercado de Valores (CNMV). The bankruptcy report valued the assets of the firm at 7336.9 million, 32% less than what was deemed by CB Richard Ellis.

Martinsa-Fadesa did not act alone. The vertiginous accounting revaluations were based on a report of Tasamadrid, 100% subsidiary of Caja Madrid, the main creditor of the estate, even while the report contained small print caveating that the scope of the revaluation was subject to unverified assumptions provided by the company itself.

The auditor, Ernst & Young, also approved these revaluations, so that Martins-Fadesa, the subject of the largest bankruptcy in Spanish business history with a liability of about 7200 million euros, was one of the few listed real estate companies which achieved a clean audit report in 2007.

Accounting for the merger of Martins and Fadesa attributed value to the real estate acquired by the company from La Coruna such that it allowed the firm to revalue accounts by 4,617 million. This transformed the purchase of Fadesa, whose 86.5% cost 3,512 million in March 2007 – into a bargain, to the point where the company accounted for 416 million as profit on the difference between the amount paid and the real value of the assets.

And things could have been worse. Another alternative valuation by CB Richard Ellis, who, according to market sources, was not accepted by the CNMV, would have, had it been used, revalued assets by 1,900 million instead of 416. Martins maintains that it commissioned the valuation by Tasamadrid “out of prudence”.

Now, new assessments made on behalf of the legal administrators sharply lower the value of the assets of the company. Under the heading of current assets, instead of 5912.8 billion contained in the company’s accounts to September 30 last, administrators valued that inventory at 4654.6 million. The difference is due almost exclusively to “tacit subtractions in accordance with the valuations received from independent third parties and amounting to 1255 million euros,” according to the report of the judicial administration.

Administrators also warn that “the balance of the current assets for the year 2007 included costs capitalized as business costs amounting to 57,291,000 euros — expenses not capitalized under General Accepted Accounting Principles”, despite which Ernst & Young did not make any objection.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.